What is the 'Network Effect'

The network effect is a phenomenon where increased numbers of people or participants improves the value of a good or service. The internet is a good example. Initially, there were few users of the internet, and it was of relatively little value to anyone outside of the military and a few research scientists. As more users gained access to the internet, adding more content, information, and services, however, there were more and more websites to visit and more people to communicate with. The internet became extremely valuable to its users.

BREAKING DOWN 'Network Effect'

The rise of social media can be directly correlated to the network effect. The more users present on Twitter, sharing comments, links, and media, the more useful the platform became to the public. Similar growth through the network effect was seen with Facebook, YouTube, and Instagram, where the escalation of users fostered more interest from even more users. Corporations have also sought to participate with these platforms, adding to the collective as they seek to engage in the expanding conversations among the many consumers who interact online.

What the Network Effect Means to Businesses

A variety of services-for-hire apps and websites also benefit from the network effect; as more professionals list online they are available as dog walkers, tutors, or even electricians, even more customers begin to rely on such directories. Ecommerce sites such as Etsy and eBay grew in popularity as more sellers joined those marketplaces and sold their products to the influx of consumers who began to embrace shopping online. Ridesharing services also evolved and grew through the support of more participants signing up and expanding their reach across cities and states. As more drivers became part of Uber and Lyft, those brands gained in market value with passengers seeking rides.

The chief hurdle for any good or service which uses the network effect is to get enough users initially so that the network effects take hold. The amount of users required for significant network effects is often referred to as critical mass. After the critical mass is attained, the good or service should be able to obtain many new users since its network offers utility.

If too many people use the good or service, negative network effects can occur, such as congestion. In the internet analogy, having too many users on the internet can hypothetically cause the speed to deteriorate, decreasing utility for users. Thus providers of goods and services which use a network effect must ensure that capacity can be increased sufficiently to accommodate all users.

  1. Networking

    Networking is a process that fosters the exchange of information ...
  2. Value Network Analysis

    Value network analysis is the assessment of the members and resources ...
  3. Network Marketing

    Network marketing is a business model that depends upon a network ...
  4. Value Network

    The connections among individuals or organizations that benefit ...
  5. User Fee

    A sum of money paid by the individual who chooses to access a ...
  6. Interactive Media

    A method of communication in which the program's outputs depend ...
Related Articles
  1. Financial Advisor

    Twitter Vs. Facebook Vs. Instagram: Who Is the Target Audience? (TWTR, FB)

    Learn why Facebook, Twitter and Instagram each appeal to different target markets of the 1 billion users of social networks worldwide.
  2. Investing

    Analysts: Twitter Should Shift Its User Focus

    Some analysts want Twitter to concentrate more on daily active users than monthly active users.
  3. Investing

    Druckenmiller-backed "LinkedIn for the 1%" Opens to the Public

    The network, called Relationship Science, aims to provide links between high profile individuals in the worlds of business, finance, and law.
  4. Insights

    Why Twitter's Problems Aren't Going Away

    As Twitter considers a paid membership option to save its business, we breakdown what its biggest hurdles are.
  5. Small Business

    Facebook Money Transfer: Transforming E-Commerce

    Facebook's payment service holds huge prospects for Facebook’s business. Here’s how it works, and how it will impact e-commerce and Facebook's business.
  6. Investing

    Why Facebook Will Never Charge User Fees (FB)

    Understand why Facebook is unlikely to ever charge users; the site's business model of leveraging free users to charge advertisers is highly profitable.
  7. Investing

    Facebook Hits 2B Users: Will China Get It to 3B?

    Facebook has 2 billion users. But to grow beyond that it will likely need to get back into China.
  8. Investing

    4 Networking Stocks that You Must Own (AKAM, CSCO)

    Understand how networking stocks fit into the technology sector. Learn about four leading networking companies that investors should own in 2015.
  9. Investing

    Did Facebook Overpay For Instagram?

    Facebook recently acquired Instagram for $1 billion. Find out if it's worth the price.
  10. Investing

    Instagram Chases Growth Overseas With Upgraded Website

    Instagram has added app features to its website, including the ability to upload images, as it seeks growth outside of the U.S.
  1. How do Internet companies profit if they give away their services for free?

    Learn how companies in the Internet sector make a profit when service, content and user applications are offered at no cost ... Read Answer >>
  2. What metrics are commonly used to evaluate companies in the internet sector?

    Discover the best metrics to evaluate Internet companies. Internet companies are unique in that their costs are low but potential ... Read Answer >>
  3. What emerging markets are best positioned to benefit from growth in the Internet ...

    Explore which emerging markets are best positioned to benefit from the growth in the Internet sector. The sector continues ... Read Answer >>
  4. Who are Facebook's (FB) main competitors?

    Explore the different social media networking sites and internet companies that are competing directly with Facebook, such ... Read Answer >>
  5. What's the difference between the income effect and the price effect?

    Learn what the price effect is and how it is related to consumer spending. Learn what two components make up the price effect ... Read Answer >>
  6. What countries are driving most of the growth of the Internet sector?

    Learn which countries are expected to lead the growth of the Internet sector in the short term. Most of the growth comes ... Read Answer >>
Hot Definitions
  1. Liquidity

    Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's ...
  2. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  5. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center